financial markets, systemic risk, information failure, rationality failure
Banking and Finance | Law | Securities Law
This Essay examines how law can help to control financial chaos. To that end, regulation should strive to not only maximize economic efficiency within the financial system but also protect the financial system itself. Any regulatory framework for achieving these goals, however, will be imperfect and have tradeoffs. Increasing financial complexity has created information failures that even disclosure cannot remedy, whereas law-imposed standardization would have its own flaws. Bounded human rationality limits the effectiveness of even otherwise ideal laws. Furthermore, the increasing dispersion of financial risk is undermining monitoring incentives. We also do not yet fully understand how systemic risk is triggered and spread. Because regulation therefore cannot prevent systemic shocks, regulation should also operate to reduce systemic consequences by stabilizing parts of the financial system afflicted by those shocks.
Steven L. Schwarcz, Controlling Financial Chaos: The Power and Limits of Law, 2012 Wisconsin Law Review 815-840